Chapter 4 Activity-Based Costing

total estimated manufacturing overhead is $900,000 and total estimated activity is 30,000 machine hours

plantwide overhead rate is 30

what level of activity is performed each time an item of a products is produced

unit level

what type of activities are performed each time a group of units is processed, regardless of how many units are in the group?

batch-level

Activity Based Costing

computes the same as job costing

plantwide overhead rate

a single predetermined overhead rate that is used throughout an entire factory

direct labor hours is an accurate allocation base when

other factors affecting overhead costs are not significant

activity dictionary

defines each of the activities that will be included in the activity-based costing system and how the activities will be measured

Batch-level activities

consists of tasks that are performed each time a batch is processed, such as processing purchase orders, setting up equipment, packing shipments to customers, and handling material. Cost at the batch level depend on the number of batches processed rather than on the number of units produced. For example, the cost of processing a purchase order is the same no matter how many units of an item are ordered.

activity measure

expresses how much of the activity is carried out and is used base for applying overhead costs

when evaluating ABC products, managers should be particularly alert to costs that contain allocations of

facility-level costs can easily lead managers astray

a technique that attempts to assign overhead costs more accurately to products is known as

activity-based costing

Activity Based Costing

-A technique that attempts to assign overhead costs more accurately to products.​ -It uses multiple allocation bases for assigning costs to products.​ -Each base represents a major activity.​ -Activity is an event that causes consumption of overhead resources.

Targeting Process Improvements Activity-Based Management

-Activity-based management focuses on managing activities to eliminate waste and reduce processing time and defects.​

Hierarchy of Activities

1. unit level each unit individually 2. batch level for a group of items 3. product level for the product as a whole 4. facility level salaries

in activity based costing any event that causes consumption of overhead resources is a

activity in activity-based costing is an event that causes the consumption of overhead resources

in activity-based costing an activity measure is

an allocation base/cost driver

Benchmarking

can be used to compare activity cost information with world-class standards of performance achieved by other organizations

unit-level activity

processing units individually, processing units by hand, consuming factory supplies

Product-level activities

testing new products, administering parts inventories, maintaining inventories of parts

Batch-level activities

processing purchase order, processing production orders, setting up equipment, handling materials

Facility-level activities

general factory administration, plant building and grounds

in the 1800s

-cost systems emphasized simplicity -direct labor and overhead was believed to be highly correlated

departmental overhead rates

-may not assign overhead correctly when a company has a range of products -may use different allocation bases in different departments

using direct-labor hours or another volume based cost driver to assign overhead

-may result in selling products at a lost -ignores other significant causes of overhead -may result in overcharging customers for products

example of ABC activities

-setting up machines -an event that causes the consumption of overhead resources -billing customers -opening bank account -admitting hospital patients

statement are true

-traditional costing systems can distort product costs -products do not all use resources in the same way

Modifying the ABC Model​

1. Selling and administrative costs should be assigned to products, where appropriate.​ 2. Facility-level costs should be removed from product costs. ​

a predetermined overhead rate in activity based costing system is called

activity rate is computed for each activity and then these rates are used to assign costs to jobs and products based on the amount of activity consumed by the job or product.

in recent years, as a percentage of total cost

direct labor has been decreasing and overhead has been increasing

activity rate is computed by

dividing total cost in the activity cost pool by anticipated number of orders activity level in the activity cost pool

When making decisions

the distinction between manufacturing costs on the one hand and selling and administrative expenses on the other hand is unimportant. -facility-level and organization-sustaining costs should be removed from product costs when making decisions -selling and administrative expenses should be assigned to products as well as manufacturing costs

ABC improves the accuracy of product costing by:

1. Increasing the number of cost pools used to accumulate overhead costs. 2. Using activity cost pools that are more homogeneous than departmental cost pools.​ 3. Assigning overhead costs using activity measures that cause those costs, rather than relying solely on direct labor-hours. 4. Activity-based costing also highlights activities that could benefit most from process improvement efforts.​

Activity-Based Costing Stage

Various Manufacturing Overhead Costs first-stage cost assignment a.Labor-related pool $/dlh unit-level activity b. machine-related pool $/MH unit-level activity c. machine setup pool $/setup batch-level d. production order pool $/order batch-level e. parts admin pool $/Part type product-level activity f. general factory pool $/MH facility-level activity

Cost Shifting from High to Low Volume Products

When a company implements activity-based costing, overhead cost shifts from high-volume to low-volume products with a higher unit product cost resulting for the low-volume products.​

activity cost pool

a "bucket" in which costs are accumulated that relate to a single activity measure in the ABC system

activity cost pool

a "cost bucket" in which costs related to a particular activity

designing and advertising a product are

product-level activities: 1. maintaining inventories of parts for a product,2. issuing engineering change notices to modify a product to meet a customer's specifications, and4. designing and advertising,5. developing special test routines when a product is first placed into production.

Product-level activities/product-sustaining

relate to specific products and typically must be carried out regardless of how many batches or units of the product are manufactured. Product-level activities include maintaining inventories of parts for a product, issuing engineering change notices to modify a product to meet a customer's specifications, and developing special test routines when a product is first placed into production.

limitations of the abc model

-overhead costs are less than proportional to activity -economists call this increasing returns to scale-as activity increases, the average cost drops. As a practical matter this means that product costs computed by a traditional or activity-based costing system will be overstated for the purposes of making decisions. The product costs generated by activity-based costing are almost certainly more accurate than those generated by a conventional costing system, but they should nevertheless be viewed with caution. Managers should be particularly alert to product costs that contain allocations of facility-level costs.

part of the design of an activity-based costing system

-what activities will be included in the system and how the activities will be measured -identify a reasonably small number of activities that explain the bulk of the variation in overhead costs -find out what activities they think are important and that consume most of the resources -determining what method will be used to measure the activities NOT PART identifying and including all activities that cause overhead costs

departmental overhead rates

-with a different predetermined overhead rate in each production department -nature of the work performed in a department will determine the department's allocation base -will not correctly assign overhead costs in situations where a company has a range of products and complex overhead costs -approach relies on a single measure of activity as the base for allocating overhead cost to products

Limitations of ABC Model

1. Products differ substantially in volume, batch size, and in activities required.​ 2. Conditions have changed substantially since the existing cost system was established.​ 3. Overhead costs are high and increasing and no one seems to understand why.​ 4. Management does not trust the existing cost system and it ignores data from it when making decisions.​ 5. The cost in each activity pool is strictly proportional to its activity measure. When this assumption is violated, the accuracy of ABC data can be called into question. ​

benefit from activity-based costing

1. Products differ substantially in volume, batch size, and in the activities they require. 2. Conditions have changed substantially since the existing cost system was established. 3. Overhead costs are high and increasing and no one seems to understand why. 4. Management does not trust the existing cost system and ignores cost data from the system when making decisions.

which of the following is the first stage of allocating overhead costs to product?

1. overhead costs are assigned to the activity cost pools 2. costs in the activity cost pools are allocated to products using activity rates and activity measures

using activity-based costing

Different products place different demands on resources. This is not recognized by conventional costing systems, which assume that overhead resources are consumed in direct proportion to direct labor-hours or machine-hours

activity rate

a predetermined overhead rate for each activity cost pool estimated cost pool total/ estimated total allocation base

facility-level activities/ organization-sustaining activities

are activities that are carried out regardless of which products are produced, how many batches are run, or how many units are made. Facility-level costs include items such as factory management salaries, insurance, property taxes, and building depreciation. These costs cannot be traced on a cause-and-effect basis to individual products. Therefore, companies that choose to implement an activity-based absorption costing system will be required to arbitrarily allocate facility-level cost to products.

Unit-level activities

are performed each time a unit is produced. The costs of unit-level activities should be proportional to the number of units produced. For example, providing power to run processing equipment is a unit-level activity because power tends to be consumed in proportion to the number of units produced

Under Activity Based Costing

the manufacturing overhead costs are allocated to products via a two-stage process. in the first stage, overhead costs are assigned to the activity cost pools. In the second stage, the costs in the activity cost pools are allocated to products using activity rates and activity measures.

The ABC system for applying overhead works just like a job-order costing system.

true

traditional cost systems tend to overcost standard products and undercost specialty products

true

Traditional Costing

uses a volume-related allocation base and assigns more costs to high-volume products, resulting in overcosting. In contrast, it assigns fewer costs to low-volume products, resulting in undercosting